Amazon Q4: Sustainably Profitable Here (NASDAQ:AMZN)

Following a strong fourth quarter earnings report, Amazon.com, Inc. (NASDAQ:AMZN) is clearly showing margin force. After posting strong third quarter results margins, the company maintained sales and margin momentum into the holiday quarter, as Amazon is now continued and sustainably profitable. Consequently, the market has rewarded shares, which are retesting their 2022 highs, opening the door for further gains.

Substantial and sustainable profits provide the business much-needed cash flows to compete and grow services to keep up with its major other technology peers, all while some peers like Meta Platforms, Inc. (META) are initiating capital return programs to investors in the form of dividends alongside its fourth quarter earnings report.

The combination of solid growth and margin expansion provides a continued runway for profit growth and while shares trade at rich valuations, I see no reason to actively take profits here.

Margins Improve, Growth Returns

After a tougher 2022, in which sales “only” grew by 9% (after the business nearly tripled since 2019) the original outlook for 2023 was highly uncertain. Following a 9% increase in first quarter sales, amidst higher retail margins but lower AWS margins, shares recovered. The worst concerns were a thing of the past by the summer as second quarter sales rose by 11%, despite inflationary pressures cooling down, with again strength driven by retail instead of the cloud business AWS.

Real strength was seen in the third quarter, with revenues up 13% to $143 billion, as the real surprise was an operating profit number of $11.2 billion, for margins equal to 7.8% of sales, driven by strength across the board.

Since October, shares have risen by more than a third to highs of $172 per share here. Much of this was driven by a general market recovery, induced by a decline in interest rates, but the recent leg move higher is driven by a convincing fourth quarter earnings report.

Fourth quarter sales ended up increasing by 14% to $170.0 billion, with revenues reported three billion ahead of the higher end of the guidance. In terms of segments, it was quite even, with North America retail, International retail and AWS sales all increasing by 13% in constant currency terms.

North American operating income of $6.5 billion on $105.5 billion in sales resulted in solid margins, comparing to essentially break-even numbers this time last year.

The international segment posted an operating loss of $0.4 billion on a $40.2 billion business, and while it posts losses, it is a massive improvement from last year as the unit traditionally has been unable to post profits, missing the dominance with the retail segment enjoys at home. AWS saw real gains, with operating profits of $7.2 billion being some two billion ahead of last year, translating into handsome margins of nearly 30% on $24.2 billion in sales. This is comforting, as AWS is operating in a fiercely competitive environment, in which all the dominant tech players look for a piece of the action, notably Microsoft (MSFT) and Alphabet (GOOGL).

Combined operating profits $13.2 billion were stronger than guided for as well, with overall margins coming in at a similar 7.8% (similar compared to the third quarter), while full year operating margins were reported at 6.8%. Despite the greater earnings power, it is a $1.00 earnings per share number (for the seasonally stronger fourth quarter) which reveals that shares trade at a low 40 times multiple.

Valuation Discussion

The company actually ended the year with a diluted share count of 10.6 billion shares, up nearly 3 percent from the year before. This is due to a higher stock price, which means that more dilution is seen from incentive packages, but the basic share count has risen slightly as well.

There is a reason for that, and unlike peers the company is not able to buy back shares (significantly), because of larger investment needs as well as the fact that the company is not as rich, operating with “just” $28 billion in net cash, but moreover facing lower profitability than many of its big technology peers. While executives confirm that capital allocation is an annual debate, it seems that investors should not be awaiting share buybacks, let alone dividends, anytime soon.

These net cash holdings are equal to just $2 and change on a per-share basis, as the company posted a $1.00 earnings per share number in the fourth quarter, a number which looks quite clean and is solid, albeit aided by the fact that the fourth quarter is seasonally stronger.

Following a solid end to 2023, the company guided likely conservative again for the first quarter of 2024. The company sees sales up 8-13% to $138.0-$143.5 billion, including a 40 basis point tailwinds from currencies. Operating income is seen between $8.0 and $12.0 billion, which at the midpoint works down to margins in the low 7s. Margins are furthermore aided by an increase in the estimated useful life of servers, adding about $0.9 billion to operating income, of course an artificial tailwind here. All this makes me very confident that earnings might top $4 per share in 2024.

What Now – A Look Through 2030

A $172 stock now gives the company a roughly $1.82 trillion valuation, or about $1.8 trillion valuation if we factor in the relatively modest net cash holdings, equal to about 3 times sales, which undoubtedly will cruise beyond the $600 billion mark.

With earnings seen at a dollar per share in the fourth quarter, in what is a seasonally stronger quarter, the question is what earnings power looks like right now. Seeing sales close to $650 billion this year and seeing margins around 7.5%, Amazon might post operating earnings close to $50 billion this year, equal to about $4 per share. If this happens, the company trades at a low forty times earnings multiple based on forward earnings.

Growth and margin expansion has to come from continued momentum and an early contribution from AI which should not only drive a recovery in the Amazon Web Services, or AWS, segments, but AI services should drive the retail segments as well (as seen with the introduction of its AI tool Rufus), providing better suggestions for consumers, alongside with additional revenue streams derived from advertising and price hikes for Prime, among others.

Other ideas and future revenue streams beyond AI are initiatives to provide broadband internet through Project Kuiper, healthcare offerings, as well as greater investments into AWS and AI at large.

Growing at close to 10%, I can easily see Amazon do a trillion dollars in sales by 2030, which combined with operating margins of 10-12% at such point in time, might drive a mighty earnings improvement, in fact it might double the estimated earnings seen this year at around $4 per share. That could yield $8-$10 in earnings per share at that point in time, which makes the current multiple look very reasonable, but we are still five years and some execution out in achieving this.

Given the move higher in Amazon.com, Inc. shares, I am not willing to add more to the position here. However, while a 40 times multiple is not very cheap, I see no reason to actively take profits as well, as continued solid grow and margin expansion are drivers behind the shares here.